When you’re looking for an area to invest in, it can be hard to know what to look for. Location is important in real estate because it’s one of the few variables you can’t change or affect later. If you buy rental homes in an area that is prone to natural disasters, for example, you risk expensive damage to the properties and dropping home values.
Beginning investors are especially nervous about investing in new neighborhoods. Here are some things to research in your quest to know more about a neighborhood.
Average Home Values
Average home values are one of the first things you will look at in any community. Most investors have a budget and the median home values will tell you if you should consider a neighborhood or if it is likely out of your reach. In addition, you will want to make sure home values aren’t too high compared with the median income. If the median income in the area is low and housing prices are high, market rent will be too small to cover a mortgage. Usually, you will have a lot of owner-occupants in these areas and fewer renters.
Cost of Living/Median Income
One of the most important things to look at when evaluating a new neighborhood or area is the cost of living and median income. While these usually work together, sometimes you will see anomalies like an area that has a high cost of living without an accompanying high income. This sometimes happens in tourist areas like beach or ski towns. Unless you are doing short-term vacation rentals, you will probably not achieve a strong cash flow in these areas.
What you usually want to see is a cost of living and a median income that match each other. If your cost of living is low, it’s okay if your median income is also lower than normal. Look at poverty levels and unemployment levels as well to see how this is affecting the neighborhood as a whole.
Neighborhoods with high appreciation usually have areas of rapid growth. This might look like new neighborhoods being built, new businesses providing jobs, and housing shortages fueled by growth. In appreciation markets, houses often cost more and cash flow is less. Instead of cash flow providing most of the income, many investors rely on the appreciation of their properties in these markets. The net worth of their properties is always rising without investing more money or continually improving the properties.
The flip side of the coin from appreciation markets is the cash flow market. While investors in appreciation markets can count on their house values increasing, values in cash flow markets are often (but not always) stagnant. In these areas, cash flow provides most of an investor’s return. House values tend to be lower and rental values are also lower. Usually found in older communities with a lower cost of living, these markets can be stable as far as income. The downsides of cash flow markets are their tendency to have stagnant home values and the crime areas they are sometimes located in. You will have to decide if you prefer cash flow or appreciation.
Occasionally you will find a market that is both good for appreciation and cash flow. While these are rare and usually short-lived (eventually the appreciation forces house prices too high for cash flow) they are the ideal market when they occur.
Study the trend of the community. Is the area attracting many young university graduates who will be earning more and able to pay higher rents in future years? Or are all the professionals leaving the town slowly? What fields do they work in? What is the average age of the community? Is the community pulling together over time, or becoming increasingly disconnected? While these factors alone cannot and should not be used to evaluate neighborhoods, when considered with the other things in this list they can help give you a picture of the area, who lives there, and if it’s on an upward trajectory, or a downward trajectory.
Proximity to Population Centers
While some rural areas are good for rental investing, in general, it’s less risky to locate your investments near large population centers. While you don’t have to buy houses in large cities, neighborhoods within commuting distance of cities will have more demand for rentals. In some cases, suburbs outside of cities are the best areas for rentals. They may attract safer, more long term tenants, compared to the high-turnover tenants in cities. In other areas, people are moving out of the suburbs and back into the urban areas. Talk to real estate agents to know what is happening in the markets you are interested in.
Local factors can affect an area in ways specific to that community. Tourist communities have outside money influencing the community. Pay attention to the location of large employment centers like factories, hospitals, prisons, and warehouses. You may have to change the way you normally evaluate when looking at these communities.
One of the factors driving neighborhood desirability is the quality of school districts found nearby. In areas with a variety of different schools, this can be a big factor. There can be a lot of competition to get into districts with high-ranking schools, and this can drive up both rental values and the number of potential renters who apply. Having more potential tenants helps you to avoid losing money due to vacancies and helps you choose high-quality, stable tenants.